If I am on a wireless network without encryption, any other computer connected to that same network could easily (with right tools & knowledge) intercept any traffic I send/receive.

If I am on a wpa2-psk wireless network, the situation is better, but another computer connected to that same network could still (with right knowledge and tools, and capturing my initial 4-way handshake) intercept and decrypt any traffic I send/receive.

My question is:
does enabling "wireless isolation" option in the access point/wireless router change this state of things? does it stop someone to be able to sniff and decrypt my traffic?

[EDIT:]
This post clarifies how someone that is connected to a wpa2-psk network (and therefore knows the pre shared key) could sniff and decrypt traffic intended for another computer of the same network: Are WPA2 connections with a shared key secure?

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Answers should establish the definition of 'Wireless Isolation'. But at least in the physical sense, it is a complete misnomer.
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deed02392Aug 8 '13 at 9:51

This is a definition that seems quite good to me: "Wireless Isolation, sometimes called client isolation, is a setting on a wireless router. When this setting is enabled it prevents a computer that is connected to the network by a wireless connection from accessing computers and resources that are connected to the network by a wired connection. It will also prevent one wirelessly connected device from connecting to another wirelessly connected device. In essence Isolating that device on the wireless network." (from: wirelessisolation.com)
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xirtylloAug 10 '13 at 8:59

does enabling "wireless isolation" option in the access point/wireless
router change this state of things?

Yes, it'll mean the wireless clients on that SSID will only be able access the upstream network (this varies based on your network design) and they won‘t be able to access other wireless clients or other clients/servers on the same segment and vice versa.

I hope this isn't irrelevant as you may already know this. If you have a reasonable sized network( home LAN) you can filter each device on your network as a 'white list'(via your router device ) , by using MAC address filtering. It may become a bit tedious to manage (as network size increases) but I feel it can help from a wifi security perspective.